Why gas prices could spiral back down again

We're in the midst of the summer driving season. Kids across the country are being piled into minivans, and retirees are rolling down the road in their RVs. For many Americans, the smell of gasoline is the scent of freedom and liberty.

So it was a bit disappointing for many that the price of this freedom surged more than 80 percent from the lows in February to the high in May before easing up again more recently. Leading the spring rebound --beyond the usual excitement on Wall Street about the coming rise in demand due to the summer driving season -- was all that chatter about a possible OPEC-Russia supply freeze deal (which never happened) and short-term supply disruptions.

The result was higher prices for energy company stocks as well as higher prices at the pump. The good news, for drivers at least, is that gasoline prices now look vulnerable to another downturn as U.S. production ramps up and overseas supply disruptions fade amid bloated inventories.

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The disruptions included everything from terrorist attacks in Nigeria to ongoing strikes in Libya to wildfires in Canada. But these have faded, along with other demand-side dynamics such as stockpiling in China and increased refinery output. The result has been a turn higher in the backlog of refined gasoline, which started the summer driving season well above any level seen since 2012 (chart above).

Gas inventories tend to bottom in the fall before surging into February. A repeat performance of that pattern would force refineries to slow output, pushing the inventory accumulation up the supply chain and ultimately pressuring crude oil prices.

Adding to that possibility, according to Morgan Stanley commodity strategist Adam Longson, is the historic connection between higher oil prices and increased U.S. drilling rig activity. No surprise then that exploration and production companies are looking to restart idled wells (especially since recent import data shows that OPEC is winning its oil price war against American shale companies as the cartel increases its market share).

Longson noted that the U.S. rig count is rising in especially high-yield shale-producing areas, which means the rebound in domestic production could be rapid. As they say, the cure for higher commodity prices is higher commodity prices because it encourages increased mining and production by profit-seekers. We're seeing this dynamic play out in real time.

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On a technical basis, keep an eye on wholesale gasoline prices, which are testing support at their 200-day moving average (red line in chart above). A breakdown here would violate the early April lows and set up a possible move down to the late February price drop near $1.10. That would be a 20 percent decline from here -- and most likely a renewed fragrance of freedom for drivers.

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.